Question 1

Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from equities: 0%

Accepted Answer

The answer of Given the following information,leverage will add how...

Question 2

The TrunkLine Company will earn £60 in one year if it does well.The debtholders are promised payments of £35 in one year if the firm does well.If the firm does poorly,expected earnings in one year will be £30 and the repayment will be £20 because of the dead weight cost of bankruptcy.The probability of the firm performing poorly or well is 50%.If bondholders are fully aware of these costs what will they pay for the debt? The interest rate on the bonds is 10%.

Accepted Answer

The answer of The TrunkLine Company will earn £60 in...

Question 3

Which of the following industries would tend to have the highest leverage?

Accepted Answer

The answer of Which of the following industries would tend...

Question 4

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Accepted Answer

If the personal tax rate on income distributed to shareholders is less than the tax rate on interest income, shareholders may prefer equity over debt due to lower tax liabilities.

Question 5

Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 50%
Personal tax rate on income from equities: 10%

Accepted Answer

The answer of Given the following information,leverage will add how...

Question 6

Issuing debt instead of new equity in a closely held firm more likely:

Accepted Answer

Issuing debt instead of new equity increases the financial leverage of a company, which means that the owner-manager has a greater obligation to meet debt payments. This obligation can act as a disciplining mechanism, making the owner-manager reduce their shirking and perquisite consumption, and instead focus on generating enough cash flow to meet the debt payments. Hence, E is the best choice.

Question 7

Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 10%
Personal tax rate on income from equities: 50%

Accepted Answer

The formula for calculating the value of leverage is: 
Leverage = (1 - Tax Shield) x (Interest Expense / Debt)

To calculate Tax Shield, we need to calculate the corporate tax rate multiplied by the interest expense.

Assuming a debt of £1, Tax Shield = 0.34 x 0.1 = £0.034

Therefore, 
Leverage = (1 - 0.034) x (1/1) = 0.966

To calculate the value of leverage, we need to subtract the value of the unlevered firm (1) from the levered firm (1.966).

Value of Leverage = 1.966 - 1 = 0.966

Therefore, leverage will add £0.966 of value to the unlevered firm per pound of debt.

Question 8

The Aggie Company has EBIT of £50,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Accepted Answer

The answer of The Aggie Company has EBIT of £50,000...

Question 9

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital
Structure becomes a 50/50 mix of debt and equity?

Accepted Answer

The cost of equity can be calculated using the Modigliani-Miller Proposition II with taxes, which states that the cost of equity increases with the debt-equity ratio. When the firm changes its capital structure to a 50/50 mix, the debt-equity ratio becomes 1. Using the formula: Cost of Equity = Cost of Equity (unlevered) + (Cost of Equity (unlevered) - Cost of Debt) * (Debt/Equity), we find that the cost of equity increases to 12%.

Question 10

Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 34%
Personal tax rate on income from bonds: 30%
Personal tax rate on income from equities: 30%

Accepted Answer

The answer of Given the following information,leverage will add how...

Question 11

The Aggie Company has EBIT of £70,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Accepted Answer

The answer of The Aggie Company has EBIT of £70,000...

Question 12

In Miller's model,when the quantity [(1-T_c)(1-T_s)= (1-T_b)],then:

Accepted Answer

This equation shows the point where the tax advantage of debt is fully offset by the higher personal taxes paid on interest income, meaning there is no net benefit to using debt financing. Therefore, it is not beneficial for the firm to hold any debt.

Question 13

An investment is available that pays a tax-free 6%.The corporate tax rate is 30%.Ignoring risk,what is the pre-tax return on taxable bonds?

Accepted Answer

The formula for calculating the pre-tax return on taxable bonds is:
Pre-tax return = Post-tax return / (1 - Corporate tax rate)

In this case, the post-tax return is 6%, and the corporate tax rate is 30%. Plugging these values into the formula, we get:

Pre-tax return = 6% / (1 - 0.30)
Pre-tax return = 8.57%

Therefore, the answer is D) 8.57%. This is the pre-tax return required for a taxable bond to be equivalent to a tax-free investment that pays 6%.

Question 14

Covenants restricting the use of leasing and additional borrowings primarily protect:

Accepted Answer

Covenants restricting the use of leasing and additional borrowings primarily protect debtholders from added risk of dilution of their claims. If a company engages in too much leasing, it increases its liabilities, which can weaken the claims of debtholders. Similarly, if a company takes on too much debt, it may have to pledge assets as collateral, which increases the risk of transfer. By restricting these activities, covenants help protect debtholders' investments.

Question 15

Indirect costs of bankruptcy are born principally by:

Accepted Answer

The indirect costs of bankruptcy, such as the loss of reputation and decreased future investment opportunities, are typically borne by the firm's shareholders, as they are the owners of the company and will see a reduction in the value of their investment. Bondholders may also experience some indirect costs, but they are typically more protected by the terms of their bonds. Managers and the federal government may also be affected by bankruptcy, but they do not typically bear the same level of indirect costs as shareholders. Suppliers may be affected by bankruptcy in terms of lost business, but this is typically considered a direct cost rather than an indirect cost.

Question 16

The TrunkLine Company debtholders are promised payments of £35 if the firm does well,but will receive only £20 if the firm does poorly.Bondholders are willing to pay £25.The promised return to the bondholders is approximately:

Accepted Answer

The promised return to the bondholders can be calculated using the formula (Face value - Purchase price) / Purchase price. Thus, the promised return to the bondholders is (35 - 25) / 25 = 0.4 or 40%. As the promised return to the bondholders is greater than the return promised to the debtholders if the firm does poorly, it is a favorable investment for the bondholders. Therefore, the best choice would be to invest in the TrunkLine Company bonds.

Question 17

When graphing firm value against debt levels,the debt level that maximizes the value of the firm is the level where:

Accepted Answer

At the point where the increase in the present value of distress costs from an additional pound of debt is equal to the increase in the present value of the debt tax shield, the firm's value is maximized. This point is known as the optimal capital structure. If the firm adds more debt beyond this point, the increase in distress costs will outweigh the benefit of the tax shield, causing the firm value to decrease.

Question 18

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

Accepted Answer

According to Miller equilibrium, the personal tax rate on equity income is equal to corporate tax rate divided by (1-personal tax rate on bond income). Thus, personal tax rate on equity income = 0.3 / (1-0.35) = 0.3 / 0.65 = 0.4615 or 46.15%. However, since the answer choices do not include 46.15%, the closest option is B, which is 7.1% rounded to the nearest tenth.

Question 19

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress)_____,and the agency costs on equity _____.

Accepted Answer

When firms issue more debt, the tax shield on debt increases because interest payments on debt are tax-deductible, reducing the firm's taxable income. The agency costs on debt increase due to the higher risk of financial distress associated with increased debt levels. The agency costs on equity decrease because debt holders have a priority claim over equity holders, which can reduce the equity holders' incentive to undertake risky projects that might not be in the best interest of the debt holders.

Question 20

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?

Accepted Answer

In a Miller equilibrium, high tax bracket investors tend to hold stocks as they seek to maximize their after-tax return. Stocks have the potential for higher returns than bonds, and they also have certain tax advantages such as the ability to offset gains with losses. Bonds, on the other hand, are more often held by low tax bracket investors seeking to maximize their pre-tax return.

Quiz 16: Capital Structure: Limits to the Use of Debt

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from equities: 0%

Which of the following industries would tend to have the highest leverage?

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 50% Personal tax rate on income from equities: 10%

Issuing debt instead of new equity in a closely held firm more likely:

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 10% Personal tax rate on income from equities: 50%

The Aggie Company has EBIT of £50,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital Structure becomes a 50/50 mix of debt and equity?

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 30% Personal tax rate on income from equities: 30%

The Aggie Company has EBIT of £70,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

In Miller's model,when the quantity [(1-T_c) (1-T_s) = (1-T_b) ],then:

An investment is available that pays a tax-free 6%.The corporate tax rate is 30%.Ignoring risk,what is the pre-tax return on taxable bonds?

Covenants restricting the use of leasing and additional borrowings primarily protect:

Indirect costs of bankruptcy are born principally by:

The TrunkLine Company debtholders are promised payments of £35 if the firm does well,but will receive only £20 if the firm does poorly.Bondholders are willing to pay £25.The promised return to the bondholders is approximately:

When graphing firm value against debt levels,the debt level that maximizes the value of the firm is the level where:

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

When firms issue more debt,the tax shield on debt ___,the agency costs on debt (i.e.,costs of financial distress) _,and the agency costs on equity ___.

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?

Quiz 16: Capital Structure: Limits to the Use of Debt

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 20% Personal tax rate on income from equities: 0%

Which of the following industries would tend to have the highest leverage?

The introduction of personal taxes may reveal a disadvantage to the use of debt if the:

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 50% Personal tax rate on income from equities: 10%

Issuing debt instead of new equity in a closely held firm more likely:

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 10% Personal tax rate on income from equities: 50%

The Aggie Company has EBIT of £50,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

Your firm has a debt-equity ratio of .60.Your cost of equity is 11% and your after-tax cost of debt is 7%.What will your cost of equity be if the target capital Structure becomes a 50/50 mix of debt and equity?

Given the following information,leverage will add how much value to the unlevered firm per pound of debt? Corporate tax rate: 34% Personal tax rate on income from bonds: 30% Personal tax rate on income from equities: 30%

The Aggie Company has EBIT of £70,000 and market value debt of £100,000 outstanding with a 9% coupon rate.The cost of equity for an all equity firm would be 14%.Aggie has a 35% corporate tax rate.Investors face a 20% tax rate on debt receipts and a 15% rate on equity.Determine the value of Aggie.

In Miller's model,when the quantity [(1-Tc) (1-Ts) = (1-Tb) ],then:

An investment is available that pays a tax-free 6%.The corporate tax rate is 30%.Ignoring risk,what is the pre-tax return on taxable bonds?

Covenants restricting the use of leasing and additional borrowings primarily protect:

Indirect costs of bankruptcy are born principally by:

The TrunkLine Company debtholders are promised payments of £35 if the firm does well,but will receive only £20 if the firm does poorly.Bondholders are willing to pay £25.The promised return to the bondholders is approximately:

When graphing firm value against debt levels,the debt level that maximizes the value of the firm is the level where:

Suppose a Miller equilibrium exists with corporate tax rate of 30% and personal tax rate on income from bonds of 35%.What is the personal tax rate on income from equities?

When firms issue more debt,the tax shield on debt _____,the agency costs on debt (i.e.,costs of financial distress) _____,and the agency costs on equity _____.

In a Miller equilibrium,what type of investments do high tax bracket investors tend to hold?

In Miller's model,when the quantity [(1-T_c) (1-T_s) = (1-T_b) ],then:

When firms issue more debt,the tax shield on debt ___,the agency costs on debt (i.e.,costs of financial distress) _,and the agency costs on equity ___.